United States: A Further Harbinger On The Application Of SLUSA

On March 30, 2015, the U.S. District Court for the Southern District of New York dismissed claims in a putative class action against New York-based hedge fund manager Philip A. Falcone ("Falcone"), his advisory firm Harbinger Capital Partners ("Harbinger"), and its affiliates.1 The court held that the plaintiffs' state law claims of fraud and negligent misrepresentation were precluded by the Securities Litigation Uniform Standards Act of 1998 ("SLUSA").2 The court rejected the plaintiffs' use of "artful pleading" and found that the state-law fraud and misrepresentation claims relating to a security not covered under SLUSA were "inevitably intertwined" with the allegations relating to the Harbinger funds' purchase of SkyTerra Communications, Inc., a "covered" security under SLUSA.3 Accordingly, the court held that the claims were precluded by SLUSA because the alleged fraud was perpetrated "in connection with" the purchase of covered securities.

The case comes in the wake of the U.S. Supreme Court's decision in Chadbourne & Parke LLP v. Troice, 134 S. Ct. 1058 (2014), and may be a "harbinger" of future SLUSA preclusion decisions, allowing SLUSA to reach to securities transactions "inevitably intertwined" with transactions that otherwise would fall outside of SLUSA's scope. Or it may simply be confined to its specific facts by courts unwilling to interpret SLUSA so broadly.

The Court's Prior SLUSA Decision

Investors initially brought a putative class action in February 2012 against Falcone, Harbinger, and its affiliates in connection with various alleged wrongdoing, including certain investments they made in several of the hedge funds managed by them (collectively, the "Funds"). In 2006, the Funds began purchasing the debt and equity of SkyTerra, a publicly traded wireless broadband company. By March 2010, the Funds' sizable position in the company placed them in a position to cause a merger with SkyTerra, rename it "LightSquared," and take it private. The plaintiffs in their lawsuit claimed that the Funds misled them about the risks involved in the Funds' investment in SkyTerra/LightSquared, which induced the investors to hold their investments in the Funds.

In September 2013, the court dismissed the state-law fraud and negligent misrepresentation claims related to the purchase of SkyTerra securities as precluded by SLUSA. These claimed misrepresentations and omissions concerned, among other things, problems with the finances at SkyTerra and the functionality of SkyTerra's technology, which was critical to obtaining government approval to operate. The plaintiffs alleged that these misrepresentations and omissions caused them to purchase or hold their investments. The court found that the allegations met the "in connection with" requirement of SLUSA because "many of the statements and omissions center on the acquisition of [covered] SkyTerra" securities.4

In denying plaintiffs' motion to reconsider, filed after Troice was decided, the court reaffirmed that the claims relating to the purchase of SkyTerra securities were precluded by SLUSA, but allowed the plaintiffs to amend their complaint.5 The plaintiffs subsequently filed a Sixth Amended Complaint, focusing on the defendants' misrepresentations and omissions about the funds' performance and the technology functionality made after March 2010. The issue then turned on the distinction between a covered security – meaning a security listed on a national exchange – and an uncovered security under SLUSA, as SLUSA is concerned only with misrepresentations that affect a covered security.

The Court's Newest SLUSA Holding

In its decision, the Court dismissed the Sixth Amended Complaint's negligent misrepresentation and fraud claims as precluded by SLUSA. In its analysis, the Court admonished the plaintiffs that they "cannot avoid preclusion by artfully pleading their claims so as to seemingly disconnect them from the purchase or sale of a covered security if the distinction drawn is superficial."6 The Court explained the "temporal question" posed: "whether the entirety of a fraud involving a security that transitions from 'covered' to 'uncovered' status in media res [in the middle of things] is precluded by SLUSA."7

For guidance the court looked to the Supreme Court's recent decision in Troice, which also addressed the "in connection with" standard. Troice consisted of three cases arising out of the Allen Stanford Ponzi scheme. There, the plaintiffs purchased certificates of deposits in Stanford's bank. In Troice, the "crux" of the litigation was the inducement to buy these certificates, which were not covered securities. The Court found that the "in connection with" requirement was not met because the fraudster, Stanford, was the owner of the covered securities that purportedly backed the certificates and was also the one who made the misrepresentations. Troice held that SLUSA did not bar the plaintiffs' claims because "a fraudulent misrepresentation or omission is not made in connection with the purchase or sale of a covered security unless it is material to a decision by one or more individuals (other than the fraudster) to buy or sell a covered security."8

As the Harbinger Court put it, Troice addressed "whether investments made through an intermediary still involve the purchase or sale of a covered security" and distinguished it from the "temporal" question raised by Harbinger. The Court reconciled Troice's narrow definition of "in connection with" with the Supreme Court's broad reading of SLUSA in Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 85 (2006), which held that the alleged fraud only has to "coincide with a securities transaction – whether by the plaintiff or by someone else." The Court reasoned that "[s]o long as someone was induced to buy, sell, or hold a covered security, any fraud claim involving those transactions (or foregone transactions) is precluded under Dabit."9

Applying this rationale, the Harbinger Court held that the plaintiffs' claims were precluded by SLUSA:

[Plaintiffs] plead a single fraud that caused them to purchase or hold their investments – a fraud that began with material misstatements and omissions made in connection with the purchase of a covered security, SkyTerra, and continued with the same misrepresentations and omissions after SkyTerra became the privately held company LightSquared. To carefully excise the allegations involving purchase and holding of interests in the Harbinger Funds during the acquisition of SkyTerra is artful pleading, and does not mask Plaintiffs' effective allegations of a single fraud with the requisite connection to covered securities.10

To further support this holding, the Court stated that the complaint "was replete with allegations concerning the acquisition of SkyTerra," and that the "substance of the Sixth Amended Complaint makes clear that it is arbitrary, from the standpoint of evaluating the entire scheme, to begin the allegations of fraud and misrepresentations at the moment LightSquared became private[.]"11 The Court also looked to the plaintiffs' derivative claims in evaluating the "substance" of the allegations, and in so doing found "further evidence of artful pleading."

SLUSA as a Continuing Bar to Claims Involving Covered Securities

The Harbinger decision provides important guidance on how courts may interpret Troice's reading of the "in connection with" requirement. If nothing else, Harbinger demonstrates the fact-sensitive inquiry required to determine SLUSA preclusion and reinforces that courts will carefully scrutinize allegations to ensure that plaintiffs not circumvent SLUSA preclusion with "artful pleading." Some courts may restrict Harbinger to its specific facts, while others may use the court's broad reading as precedent for similarly "intertwined" transactions involving both covered and uncovered securities. Stay tuned as this area of law continues to develop.


[1] For a discussion of Harbinger's 2013 settlement with the SEC, see Marc D. Powers, Mark A. Kornfeld, and Joanna F. Wasick, The SEC Falcone Settlement: A Harbinger of Things to Come?, ABA BUSINESS LAW TODAY (Oct. 2013); Marc D. Powers, Mark A. Kornfeld, and Joanna F. Wasick, BakerHostetler Executive Alert, The Falcone Settlement: A Harbinger of Things to Come? (Sept. 3, 2013).

[2] In re Harbinger Capital Partners Funds Investor Litig., 2015 WL 1439520, at *5 (S.D.N.Y. Mar. 30, 2015). The court dismissed without prejudice the state law derivative claims, declining to exercise supplemental jurisdiction.

[3] Id.

[4] In re Harbinger Capital Partners Funds Investor Litig., 2013 WL 5441754, at *15 (S.D.N.Y. Sept. 30, 2013).

[5] In re Harbinger Capital Partners Funds Investor Litig., 2014 WL 3694991 (S.D.N.Y. July 7, 2014).

[6] In re Harbinger Capital Partners Funds Investor Litig., 2015 WL 1439520, at *5.

[7] Id.

[8] Troice, 134 S. Ct. at 1066.

[9] In re Harbinger Capital Partners Funds Investor Litig., 2015 WL 1439520, at *6.

[10] Id. at *7.

[11] Id. at *8.

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